The second part of the “Golden Fetters” indictment, to quote a recent statement of it (Bordo 2010, p. 40), is that “The Great Depression spread across the world via the fixed exchange rate gold standard.” In Eichengreen’s (1992, p. xi) earlier words, the international gold standard “transmitted the destabilizing impulse from the United States to the rest of the world.” This description of events has some truth to it – but is misleadingly incomplete. The destabilizing impulse, as emphasized in the previous section, came from the Federal Reserve and Bank of France sterilizing gold inflows and thereby absorbing ever-greater amounts of gold. “These policies,” as Ben Bernanke (2010, p. 15) has noted, and not the gold standard as such, “created deflationary pressures in deficit countries that were losing gold.” More importantly, as discussed above, counties like the United Kingdom were already headed for deflation once they decided to return to the gold standard at their prewar parities while their price levels were well above their prewar (and equilibrium) levels.

The interwar period shows us a case where central banks – not the gold standard – ran the show. To put it mildly, they failed to run it as well as the classical gold standard. As Richard H. Timberlake (2005) has emphasized, it is illogical to blame “the international gold standard” for the interwar disaster. The international gold standard worked well in the pre-War period when central banks were less active in trying to manage gold flows (and in many countries, like the United States and Canada, did not yet exist). Blame for the unfortunate results of the interwar system falls instead on decisions to resume at the old parity and on the discretionary policies of central bankers. The illogic is compounded when the failure of the interwar system is taken to provide evidence in support of an argument for giving central banks more discretion than they have under an automatic international gold standard.

The interwar experience does carry a lesson for advocates of reinstating an international gold standard. It indicates that the international gold standard works best when it works most automatically. A valid point is therefore made by Ben Bernanke’s lecture slide that reads, “the effects of bad policies in one country can be transmitted to other countries if both are on the gold standard.” Bad monetary policies can come from discretionary central banks in other countries. It would therefore be better for all participating countries if a treaty reinstating an international gold standard could also institute enforceable constraints against central banks disturbing the peace. The most thorough constraint is to eliminate central banking in favor of free banking. Among other things, free banking would decentralize currency issue and gold reserve holding, subjecting it to competitive interbank clearing discipline, and thereby all but eliminate the risk of large or persistent money-supply errors.